Making the case for international exposure

AudreyKaplan

Audrey Kaplan is a senior portfolio manager at Federated Investors Inc.,
managing the Federated InterContinental Fund, a fund that provides broad
international exposure and invests in foreign economies across both developed
and emerging markets. Kaplan has 23 years of
investing experience. Prior to joining Federated in August 2007, she managed the Rochdale Atlas Portfolio in New York, was a hedge fund strategy consultant for
BlueCrest Capital Management in London, worked in European quantitative strategy
for Merrill Lynch in London, researched global emerging markets at Robert
Fleming in London, and completed equity, fixed-income and derivative analysis
with Salomon Brothers in Tokyo and New York. Kaplan earned a B.S from Rensselaer
Polytechnic Institute and a MiF from London Business School. She is a member of
the Society of Quantitative Analysts, Stamford Society of Investment Analysts,
100 Women in Hedge Funds, and the Quantitative Work Alliance for Applied
Finance, Education and Wisdom.

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As the domestic stock indices appear to be on a path that could take them to new highs this year — a view shared by our asset-allocation team at Federated — let's not forget the case for including and even increasing the international exposure in a typical equity investor's portfolio.

For one, the overall performance of non-U.S. equities has been much better so far this century, particularly in faster-growing emerging markets and through developed countries geared to that growth. The U.S. equity market's performance ranked among the top five globally only once in the past 12 years, and that was in 2011, when the S&P 500 appreciated a mere 2%! That outperformance was driven by investors' perception of the U.S. financial markets as a relative haven from the turmoil in Europe and the belief Chinese economic activity was going to slow dramatically.

Outside of this "safe haven" effect, which also was evident during the 2008 market trough when the global financial crisis hit full force, there have been better investment opportunities outside the U.S. equity markets over multiple decades.

Additionally, global economic growth has been and should continue to grow faster outside of the United States this year and for the foreseeable future. Consensus Economics projects real 2013 U.S. GDP will grow 1.9% vs. 2.8% for the rest of the world; five-year projections put annual growth in the U.S. at 2.5% vs. 3.2% elsewhere. This nearly 30% growth differential includes the slower-growing and maturing economies of Europe and Japan. Exclude them, and the differential grows substantially wider.

This gap is significant for investors because economic growth is a fundamental driver of corporate earnings growth. Two examples include South Korea and Brazil, where economic growth is expected to be significantly above that of the United States over the coming years. Not surprisingly, the forward earnings-per-share growth for companies in these two countries is projected to increase 20% for 2013, nearly doubling that for the S&P 500. P/E multiples also suggest many global stocks remain a bargain. For example, the multiple for the MSCI All Country World-Ex U.S. Index is around 12, well below its historical mean of 17.

Finally, while the major U.S. indices are nearing all-time highs, that's not the case elsewhere. Consider the Chinese market. The MSCI China Index is still roughly 30% off its 2007 peak despite a recent rally that has the index up 25% from its recent low on Sept. 5, 2012, and there is more upside potential based on attractive valuations.

So as investors start dipping their toes back in the equity waters — flows into U.S. equity funds and exchange-traded funds (ETFs) hit a record $39.3 billion in January, according to TrimTabs Investment Research, a U-turn from the past five years' record outflows — they shouldn't limit themselves just to U.S. names. The waters elsewhere can be just as fabulous — if not more so.

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